Optimal Corporate Taxation Under Financial Frictions

Optimal Corporate Taxation Under Financial Frictions

By Eduardo Davila, Benjamin Hébert
September 2019Working Paper No. 3594

We study optimal corporate taxation when firms are financially constrained. We describe a corporate taxation principle: taxes should be levied on unconstrained firms, which value resources inside the firm less than constrained firms. Under complete information, this principle completely characterizes optimal corporate tax policy. With incomplete information, the government can use payout policy to elicit whether a firm is constrained, and tax accordingly. In our static model, optimal corporate taxation can be implemented by a corporate dividend tax, and in our dynamic model, the optimal sequence of mechanisms can also be implemented by a corporate dividend tax.

Keywords
corporate taxation, dividend taxation, financial frictions